Academic journal article Journal of Business Economics and Management

The Impact of the Financial Crisis on Insider Trading Profitability in Belgium

Academic journal article Journal of Business Economics and Management

The Impact of the Financial Crisis on Insider Trading Profitability in Belgium

Article excerpt

1. Introduction

In 2007, the subprime mortgage crisis emerged in the US and rapidly spread across the world-wide financial system. This global financial crisis was marked by the failure of several financial institutions and the fast decline of various stock market indices. The financial turmoil led to a chaotic environment in which it was difficult for market participants to determine the fundamental value of companies and their capability to withstand the financial crisis.

An interesting research question against this background is whether the increased uncertainty surrounding the financial crisis enlarged the opportunities of insiders to exploit their informational benefits. Prior studies have already evidenced that insiders are generally better informed about their firm's prospects as they receive relevant information in a more timely manner (Ching et al. 2006; Li, Zhang 2006; Cheng, Leung 2008). For example, insiders seem to sell considerably more shares prior to the bankruptcy filing of their company (Gosnell et al. 1992; Seyhun, Bradley 1997). In addition, numerous studies have documented that insiders are able to convert their informational benefit into excess stock market returns (e.g. Seyhun 1986; Lakonishok, Lee 2001; Del Brio et al. 2002; Wisniewski, Bohl 2005; Bajo, Petracci 2006; Cheuk et al. 2006; Betzer, Theissen 2009). Also, using the 1997 Asian financial crisis as a test case, Cheong et al. (2007) and Lim et al. (2008) concluded that the efficiency of financial markets is adversely affected by the occurrence of a financial crisis. Based on these previous findings, we hypothesize that the highly uncertain and volatile stock markets during the recent financial crisis exacerbated the information asymmetry between insiders and other market participants and created additional opportunities for insiders to gain excess returns.

Given the large weight of financial institutions, the Belgian stock market was especially vulnerable to the financial crisis. This provides an interesting environment to test this hypothesis. Using a unique dataset of insider trading transactions in Belgium, we evaluate this research question by testing whether higher abnormal profits were earned during the financial crisis compared to non-crisis periods.

Consistent with previous studies, we proxy the informational advantage of insiders by determining the profitability of their trades (e.g. Frankel, Li 2004; Park, Shin 2009). We apply event study methodology and measure trading profits as the cumulative average abnormal return after the trading event. A correction for thin trading is applied to infrequently traded securities. Furthermore, transactions with overlapping event windows are excluded from the sample to avoid event clustering.

Our empirical findings confirm that during the peak of the financial crisis, insider trading resulted in considerably higher profits. This finding suggests that the crisis enlarged the informational benefits of insiders.

These results are of potential interest to market regulators. They indicate that supervisory authorities should be aware of the greater information asymmetry and stock market inefficiency during a financial crisis. Consequently, stricter enforcement of insider trading regulation and more supervision might be needed during these periods.

Our results are also of importance to companies. Previous research has identified information asymmetry as an important driver of the cost of capital. In addition, Love et al. (2007), and Ivashina and Scharfstein (2010) have shown that credit lines contract in the months and even years following a financial crisis. Consequently, companies have an interest in limiting the informational benefits of their insiders in order to retain a sufficient supply of external capital. Maybe, reducing this information asymmetry could be achieved by increasing corporate transparency.

Our study contributes to the literature in several ways. …

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